August 2017

Aug 4, 2017

U.S. equity markets delivered robust gains in the second quarter, extending the rally that began last November. Stocks recorded the bulk of their gains in late April and May, as first-quarter earnings reports managed to outpace even elevated expectations. In addition to the upward trend in corporate earnings, U.S. business confidence indicators rose as well. These and other factors combined to create a calm financial market environment, with the Chicago Board Options Exchange Volatility Index – better known as VIX – hovering at its lowest levels on record. Even potential political headwinds, such as the appointment of a special counsel to investigate Russia’s interference in the 2016 election and Republicans’ difficulty in repealing and replacing Obamacare, caused little angst in the markets.

More than six months into the new presidency, enthusiasm around the Trump administration passing certain policies seems to have waned. Trump began his term with an aggressive agenda. His wish list is big: repeal and replace the Affordable Care Act (Obamacare), overhaul the budget, bring about comprehensive tax reform and deliver an infrastructure plan. However, there has been little movement on Trump’s pro-growth agenda as of yet. The market is anticipating tax reform early 2018 and we are carefully watching policy changes as we move forward.

The Federal Reserve (Fed) raised short-term rates for the fourth time this cycle in June and indicated it will embark on a program to reduce the massive amount of bonds purchased during the 6 years of what is known as “quantitative easing”. The Fed also adjusted its inflation projections. It now believes inflation will fall short of its 2% target for the year and remain below that threshold in the short term. Analysts anticipate at least one more rate hike in 2017. The Fed will continue to gradually normalize monetary policy, but the pace could be slower than currently projected. Interest rates will increase modestly over time, but will likely remain at historic lows.

The global economic environment also continues to improve, with most regions of the world on track to deliver robust growth in 2017. As in the first quarter, international stocks generally outperformed US equities overall. European economies have begun to show signs of rebounding, and investors have greater confidence following the results of the French and Dutch elections. Even though China continues to go through structural reforms, its economy is expected to grow at potential this year.

Emerging markets (EM), typically characterized as small developing countries with superior growth prospects, have shown robust returns over the past several quarters. EM equities have been the best performing equity region and EM bonds have been the best performing fixed income market so far this year. The performance of both asset classes has been helped by the synchronized growth of the global economy and the weakness in the US dollar.

Given the unknowns of the Trump administration, we anticipate stock market volatility to increase in the second half of 2017. Nevertheless, we continue to believe equities should outperform bonds, cash and inflation. Corporate fundamentals are strong and valuations are not unreasonably high. We expect corporate earnings to increase in 2017 which will be critical to push equities higher.

While it is possible the Federal Reserve will raise short term interest rates again this year, it should not be a major disruption as evidenced by the market’s reaction to the June and March increases. We expect a slight upward bias in interest rates driven by Federal Reserve activities for the remainder of 2017.

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